The junk bond market continues to show signs of cracking…

For months now, we’ve pointed to the decline of junk bond values as one of the biggest red flags in the entire market. The bond market is where companies, countries, and individuals go to borrow money. It’s far larger and more important than the stock market. The U.S. bond market, for instance, is about twice as large as the U.S. stock market.

If an economy, industry, or company is in trouble, warning signs usually appear in the bond market long before they show up in the stock market. We’ve focused specifically on the bond market’s riskiest offerings, junk bonds, which are bonds issued by companies with shaky balance sheets. They’re riskier than bonds issued by strong companies, so they pay higher yields.

When the economy slows down, companies in poor financial shape feel the pain first. That’s why junk bonds often point out problems before other assets do.

•  On Monday, one of the biggest junk bond ETFs hit its lowest level in over six years…

SPDR Barclays High Yield Bond ETF (JNK) is the second-largest junk bond ETF in the U.S. It holds $10 billion worth of junk bonds. On Monday, it dropped to its lowest level since July 2009.

The chart below shows JNK’s performance since then. As you can see, it’s been in a downtrend since June 2014. JNK has fallen 9% this year. It’s lost 4% in the past three months alone.

 

Junks bonds are a huge portion of the overall corporate bond market. Yesterday, Financial Times reported that half of all corporate bonds have a junk rating.

Since 2007, the proportion of corporate bonds S&P has rated speculative-grade, or junk, has climbed to about 50 per cent from 40 per cent.

•  Many companies are struggling to pay their debts…

Yesterday, Financial Times reported that companies are defaulting on bond payments at the highest rate since the financial crisis.

Currently, 99 global companies have defaulted since the year began, the second-greatest tally in more than a decade and only exceeded by the financial crisis which saw 222 defaults in 2009, according to Standard & Poor’s. U.S. companies account for 62 of this year’s defaults.

Many more companies are likely to default. Last month, The Wall Street Journal reported that corporate downgrades are at their highest level since the Great Recession.

Standard & Poor’s Ratings Services downgraded U.S. companies 297 times in the first nine months of the year, the most downgrades since 2009…with just 172 upgrades.

A downgrade is when a credit agency lowers a company’s credit rating. This happens when a credit agency thinks a company’s financial health is getting worse. The huge spike in downgrades this year suggests the health of the entire economy is deteriorating.

•  The Federal Reserve has encouraged companies to borrow obscene amounts of money, which is a big reason for this mess…

In 2008, the Fed dropped its key interest rate to effectively zero. At the time, it was trying to fend off the worst economic downturn since the Great Depression. The Fed has held rates at effectively zero ever since.

Low rates make it cheap to borrow money. The past seven years of incredibly low rates have fueled a corporate borrowing binge…

U.S. companies have issued $9.3 trillion in new bonds since the financial crisis. That includes $1.4 trillion in new bonds in the last year alone, according to the Securities Industry and Financial Markets Association. That’s a new all-time record. But U.S. companies will probably top it this year. They’ve already issued $1.3 trillion in bonds through October. That’s 8.4% more than the same period last year.

All this borrowing has left corporate America with a massive debt load. In September, financial news site MarketWatch reported that U.S. corporations outside the financial sector owe $7.7 trillion in debt. That’s nearly 50% more than a decade ago.

•  Many U.S. companies could struggle to pay back all this money…

Because profits for major U.S. companies are shrinking.

As of Friday, 95% of companies in the S&P 500 had reported third-quarter results. The S&P 500 is on track to post a 1.6% decline in earnings for the third quarter, after 0.7% drop in earnings in the second quarter. It would be the first back-to-back quarters of declining earnings for the S&P 500 since 2009.

Declining profits means less money for companies to pay off loans. Many of the most indebted companies will have no choice but to default.

•  Meanwhile, the stock market isn’t as healthy as it looks…

The S&P 500 fell 11% in six days in late August. It was the first time since 2011 the U.S. stock market had dropped 10% or more. However, a strong rebound has pushed U.S. stocks up 12% from their August low. Today, most U.S. stock indexes are back near all-time highs.

Yet only a few companies are driving the rally…

The chart below compares the Dow Jones Industrial Average and the Russell 2000 since the market bottomed in late August. The Dow tracks the performance of 30 giant U.S. companies. The Russell 2000 tracks 2,000 smaller companies.

The Dow has gained 13.6% since late August. The Russell 2000 has gained just 5.7%.

•  In a healthy market, large stocks and small stocks usually rise together…

But right now, a small number of huge companies is driving the rally…

Earlier this month, E.B. Tucker, editor of The Casey Report, explained why this is a bad sign for the “real economy.”

The Dow Jones Industrial Average is made up of companies like General Electric, IBM, Visa, and other firms you’ve heard of. These are huge businesses. They also have widely-traded stocks. Investors know they can sell these stocks quickly if they have to.

The Russell 2000 Index, on the other hand, tracks much smaller companies, like Anacor Pharmaceuticals, CubeSmart and Casey’s General Stores. You probably haven’t heard of most of the companies in the Russell 2000. But the performance of these stocks is a good indication of what’s really going on in the economy. When investors favor larger companies over smaller ones at a rate that doubles the performance of the latter, it’s an ominous sign for the overall market.

•  Signs of an unhealthy market are adding up…

The junk bond market is under stress. Earnings for U.S. companies are shrinking. And a handful of large stocks are driving the stock market rally.

We believe the U.S. stock market is topping out. The current bull market in U.S. stocks started in March 2009. It’s now 80 months old. That’s 30 months older than the average bull market since World War II.

Bull markets don’t die of old age, but they all die eventually. When this bull market officially ends, it will hit a lot of investors by surprise. There’s no reason to be one of them. We suggest taking a few simple steps to safeguard your wealth now…before the mainstream media tells you the party is over.

To start, you should hold a significant amount of cash and some physical gold. You may also want to hedge your portfolio by shorting (betting against) companies most vulnerable to an economic slowdown.

These are the first steps every investor should take. But there are many more straightforward ways to “crisis-proof” your wealth.

We recently published a book on this topic. It’s called Going Global 2015. It features some of the most important research we’ve ever published.

For example, Chapter 4 explains the best ways to own foreign currencies. This could help protect your purchasing power if the value of the dollar drops. Chapter 5 explains how to buy foreign stocks. This could help protect you if U.S. stocks fall into a bear market.

Keep in mind, these are not just strategies for rich people. Going Global is packed with easy-to-follow steps every investor can take immediately. Click here to learn more.

Chart of the Day

Defense stocks are rallying…

On November 13, a group of terrorists orchestrated a series of attacks in Paris. They killed 130 innocent civilians and injured hundreds more. It was a horrible tragedy.

France responded by launching massive airstrikes against ISIS, the terrorist group claiming responsibility for the attacks. The U.S. military also stepped up attacks on ISIS.

Now defense stocks are surging…

Today’s chart tracks three of the largest U.S. weapons makers, Lockheed Martin (LMT), Raytheon (RTN), and Northrop Grumman (NOC), since November 13.

Each stock has outperformed the broad market since the Paris attacks. Lockheed Martin and Raytheon hit new 52-week highs on Friday.

Regards,

Justin Spittler
Delray Beach, Florida
November 25, 2015

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